Tuesday, October 13, 2009

The Global Guru: Your Secret "Edge" to Getting Rich

Nicholas Vardy's The Global Guru
October 13 , 2009
Vol. 4, No.37

Fellow Investor,

Your Secret "Edge" to Getting Rich in Global Stocks

The secret to getting rich is simple -- but it's not easy...

Just pile all of your money into a small cap stock--say, Microsoft, at a split-adjusted 8 cents a share in March 1986 -- get really lucky, and hold on for the ride.

But assuming you are unskilled at picking the next Microsoft, the single best way you can get rich is to invest in a portfolio of highly volatile, small cap stocks.

Some stocks will tank. Others will soar.

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But over time, the gains from your winners will make up for your losers.

Now, this style of investing is no "free lunch." After all, small caps are much more volatile than their large cap counterparts. You're guaranteed a wild ride -- and one you may not have signed up for had you known about the stomach churning involved up front. But it is a strategy that will get you where you want to go faster than you can ever imagine.

So, as a specialist in global markets, I began to wonder. If betting on small caps is your single best way to generate wealth in U.S. markets, can you just replicate this strategy in even more profitable (and volatile) global markets?

The short answer, I believe, is "yes."

Understanding the "small cap effect" and how you can apply it to investing in global markets just might be one of the most powerful -- yet simplest -- ideas in your global investing tool kit.

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Your Secret "Edge": The Small Cap Effect Across Global Markets

When the economy turns around, it is usually the small and nimble companies that are able to react first. Small caps are the canary in the coal mine for economic recovery.

Comparing the S&P 500's performance against the Russell 2000 small cap index over the last six months confirms this.

Now, let's see how small caps fare in various global markets.

Let's look at three examples -- one from a developed economy; one from a developing economy; and one from emerging markets as a whole.

Let's start with Japan, one of the world's most developed economies, and the world's second-largest economy after the United States.

Comparing the performance of the iShares MSCI Japan Index (EWJ) with the iShares MSCI Japan Small Cap Index (SCJ) over the last six months, and the answer becomes clear. Japanese small cap stocks have outperformed their large cap counterparts by a comfortable margin.

Next, let's look at Brazil.

This comparison is slightly more difficult because the Market Vectors Brazil Small-Cap Index ETF (BRF) is less than six months old.

Nevertheless, a comparison of its performance versus the iShares MSCI Brazil Index (EWZ) is clear.

Small caps in Brazil handily outperform their large cap counterparts -- and by close to a two-to-one margin.

Finally, let's look at emerging markets as a whole.

Compare the performance of the SPDR S&P Emerging Markets Small Cap ETF (EWX) with the iShares MSCI Emerging Markets Index (EEM).

Here again, the small caps have substantially outperformed their large cap counterparts over the past six months.

Now, if I were doing a serious study, I'd parse the data for country and sector weightings. I'd look at the data over a much longer period of time. And, I'd compare the performance of each small cap index to its large cap counterpart, on a risk-adjusted basis.

That all said, I believe that my findings would confirm that small caps outperform their large cap counterparts in the global markets, just as they do in the United States.

Your Secret "Edge": Bigger Than You Think

In fact, I believe that the small cap effect may even be stronger in developing global stock markets than in developed markets like the United States and Japan.

First, investing in global small caps exposes you to a whole universe of stocks. While many large, global companies are listed directly on U.S. exchanges in the form of American Depository Receipts (ADRs), global small caps are listed almost exclusively on their home exchanges. And few sectors beyond the ranks of banks, oil companies, telecom providers, and occasional high tech companies are represented.

That's why the market-cap-weighted S&P Emerging SmallCap Index is concentrated heavily on consumer goods, materials and hardware. Focusing on these sectors, you get the exposure to the fast-growing local domestic market, which you don't always get in foreign large caps. For example, the largest holding in the S&P Emerging SmallCap Index is Aspen Pharmacare Holdings Limited, a South African-based company that is Africa's largest pharmaceutical manufacturer. But it also has businesses throughout Africa, South America, Australia, India and the United Kingdom.

Second, doom and gloom headlines notwithstanding, some global economies were not hurt as badly as others during the credit crunch, simply because they had little exposure to the financial crisis. Smaller companies also are more nimble and flexible and can better address changing environments quickly. So, once the global economy drew back from its precipice, small caps fundamentally unaffected by the financial crisis recovered before the large, global conglomerates. Put another way, global small caps are the untold "decoupling" story.

Third, a portfolio of small caps may be actually less risky than their large cap counterparts. This flies in the face of conventional wisdom, which has it that small-cap emerging market companies are riskier than traditional emerging market investments. But consider that although an individual small cap may be much more risky because of its narrow focus, in the aggregate, you have much more diversification with a group of small-cap investments. Here's a particularly revealing statistic. Last year, the SPDR S&P Emerging Markets Small Cap ETF (EWX) suffered a 54.62% decline. But that was no worse than the decline in the large-cap focused iShares MSCI Emerging Markets Index (EEM). Meanwhile, this year, the small-cap index and its related ETF have strongly outperformed the large-cap benchmark.

Finally, as a small investor, you have a huge advantage over large institutional money and hedge funds. They have issues of liquidity and the threat of huge drops in the value of their holdings to deal with.

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Nicholas A. Vardy
Editor, The Global Guru

P.S. Investors in my trading service, Global Bull Market Alert, know all about making big money in small stocks. My subscribers booked gains of 126.5% in a Chinese Internet play just yesterday -- in just six weeks. To find out the name of our next big winners, sign up for Global Bull Market Alert today.

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